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Consider This Before Buying Birchcliff Energy Ltd. (TSE:BIR) For The 4.8% Dividend

Simply Wall St

Could Birchcliff Energy Ltd. (TSE:BIR) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

Birchcliff Energy pays a 4.8% dividend yield, and has been paying dividends for the past three years. It's certainly an attractive yield, but readers are likely curious about its staying power. Some simple analysis can reduce the risk of holding Birchcliff Energy for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Birchcliff Energy!

TSX:BIR Historical Dividend Yield, November 18th 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 91% of Birchcliff Energy's profits were paid out as dividends in the last 12 months. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable - still, we think it is a concern.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. The company paid out 83% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It's good to see that while Birchcliff Energy's dividends were not well covered by profits, at least they are affordable from a free cash flow perspective. Still, if the company continues paying out such a high percentage of its profits, the dividend could be at risk if business turns sour.

Is Birchcliff Energy's Balance Sheet Risky?

As Birchcliff Energy's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 2.46 times its EBITDA, Birchcliff Energy's debt burden is within a normal range for most listed companies.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 2.40 times its interest expense, Birchcliff Energy's interest cover is starting to look a bit thin.

Consider getting our latest analysis on Birchcliff Energy's financial position here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past three-year period, the first annual payment was CA$0.10 in 2016, compared to CA$0.10 last year. This works out to be a compound annual growth rate (CAGR) of approximately 1.6% a year over that time.

We like that the dividend hasn't been shrinking. However we're conscious that the company hasn't got an overly long track record of dividend payments yet, which makes us wary of relying on its dividend income.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Birchcliff Energy's EPS have fallen by approximately 23% per year during the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We're not keen on the fact that Birchcliff Energy paid out such a high percentage of its income, although its cashflow is in better shape. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. Using these criteria, Birchcliff Energy looks quite suboptimal from a dividend investment perspective.

Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 5 analysts we track are forecasting for the future.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.